M&A: Hostile Takeover, Defensive Strategies and Merger Arbitrage

Hostile Takeover:

• Mostly are off-market purchase, can turn friendly and vise versa.
• Hostile threats have a disciplining effect on target's managers but also bring higher premium (benefit for target).
• Hostile carry element of surprise, allow bidder to take advantage of poor target valuation, reduce the likelihood of competing bidders, limit hold-out problems (target's board play for time), bypass highly entrenched board, create pressure for board to go back to the negotiation table (opportunistic benefits for acquirer).
• Costs: 
• no due diligence
• protracted (lasting longer than expected), difficult to win control, high premium.
• Tougher merger integration --> strong enough to withstand adverse conditions, lots difficulty, require great efforts. 

Merger Arbitrage

• Arbitrageur's strategy:
• Long position on target shares --> buy target shares, hoping the price will go-up since the competitive bids will drive-up acquirer's offer price and arbitrageur will earn more.
• Until the acquisition is completed, the stock of the target typically trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock.
• Short position on bidder shares (usually for stock deal) --> short the acquirer shares, hoping the price will go-down for unexplained reasons.
• The acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur may then short sell the acquirer and buy the stock of the target. This process is called "setting a spread." After the merger is completed, the target's stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. The arbitrageur delivers the converted stock into his short position to complete the arbitrage.
• Collar --> the exchange ratio is not constant but changes with the price of the acquirer.
• Net position is highly leveraged.
• Risks: 
• The deal will fail and the price will go down significantly.
• Degree of exposure amplified through leverage.
• Arbitrage spread:
• Difference between the offer price and the target's post announcement market price.
• Positive: higher offer.
• Roles of Arbitrageur
• Providing liquidity: merger arbitrageurs provide liquidity that target shareholders demand to avoid blow-up risk.
• Ameliorating shareholder hold-out problems: Arbitrageurs round up free float shares in the market, making the coordination problem less severe.
• Information revelation: Is another higher offer forthcoming? What is the probability of deal failure?

Takeover Defence Strategies

• Why do targets need to defend against hostile takeovers?
• Keeping management entrenched (firmly established and difficult to change)
• Protecting stakeholders (eg employees) welfare.
• Deterring (prevent the occurrence of) opportunistic and not serious bidders.
• Providing a fair M&A playground for all shareholders
• Extracting more value for target's shareholders.
• Buying more time.
• Wrestling control of the process back to the target.
• Reducing shareholder holdout by forcing target shareholders to coordinate.
• Giving the board more bargaining power at the negotiation table
• Making acquirers to offer higher premium.
• Common Strategies:
• Pre-emptive defences: 
• Implemented before a hostile bid.
• Legal mechanisms and some strategic & financial defences.
• Reactive Defences:
• Defences put in place after a hostile bid is made.
• Tailored to defeat or discourage a specific bidder.
• Defensive strategies in Australia:
• Poison pills not widely used (Takeover Panel Guidance Note 12) such as:
• issues new share/repurchase shares significantly in the context of the bid.
• Acquiring major asset or disposing one.
• Undertaking significant liabilities or materially changing terms of its debt.
• Declaring a special or abnormally large dividend.
• Significantly changing company share plan.
• Entering into joint venture.
• Staggered Board
• Board recommendations: significant impact on shareholders decisions, often accompanied by independent expert valuation reports, can be supported by marketing campaign in the media.
• Value diversion: special dividend, share buyback.
• Information management: updating profit forecasts, bring forward the release of confidential information.
• Restructuring: sale of non-core assets, increasing leverage, de-merger.
• Creating an auction environment: approaching potential white knights, setting up an auction for an asset/division.
• Taking advantage of resistance from regulators/public: Takeover Panel/Foreign Investment Review Board rulings.
• Most importantly, asking for a higher price --> pointing out that price < synergy, attacking acquirer's financing, stock price potential (in stock deals)
• Empirical Results for Australia (Maheswaran and Pinder, 2005):
• Bid resistance increases target shareholder wealth in post announcement period.
• Bid hostility associated with larger targets, weak target performance.
• Hostility unrelated to size of premium offered.
• Hostility decreases probability of success, increases likelihood of revision, does not scare off competitors.